Financial statement information is most useful if owners and managers can use it to improve their company\u2019s profitability, cash flow, and value.<\/p>\n
Ratio analysis looks at the relationships between key numbers on your company\u2019s financial statements. After you calculate the ratios, you can compare them to industry standards — and the company\u2019s past results, projections, and goals — to highlight trends and identify strengths and weaknesses.<\/p>\n
The hypothetical situations that follow illustrate how ratio analysis can give company decision-makers valuable feedback.<\/p>\n
The recent increases in Company A\u2019s sales figures have been impressive. But the owners aren\u2019t certain that the additional revenues bring more profits. Net profit margin <\/em>measures the proportion of each sales dollar that represents a profit after taking into account all expenses. If Company A\u2019s margins aren\u2019t holding up during growth periods, a hard look at overhead expenses may be in order.<\/p>\n Company B extends credit to the majority of its customers. The firm keeps a close watch on outstanding accounts so that it can contact slow payers. From a broader perspective, knowing the company\u2019s average collection period <\/em>would be useful. In general, the faster Company B can collect money from its customers, the better its cash flow will be. But Company B\u2019s management should also be aware that if credit and collection policies are too restrictive, potential customers may decide to take their business elsewhere.<\/p>\n Company C has several product lines. Inventory turnover <\/em>measures the speed at which the business sells its inventories. A slow turnover ratio relative to industry standards may indicate that stock levels are excessive. The company can use the excess money tied up in inventories for other purposes. Or it could be that inventories simply aren\u2019t moving, and that could lead to cash problems. In contrast, a high turnover ratio is usually a good sign — unless quantities aren\u2019t sufficient to fulfill customer orders in a timely way.<\/p>\n These are just examples of ratios that may be meaningful. Once key ratios are identified, they can be tracked on a regular basis.<\/p>\nGetting Paid<\/strong><\/h3>\n
Inventory Management<\/strong><\/h3>\n